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Opinions expressed in this newsletter clo not
necessarilv reflect the views of the management
of the Feeleral Reserve Bank of San Francisco,
or of the Board of Covernors of the Federal
Reserve System.
of savings deposits and other non-transaction
instruments, which yield about the same as
N OWs but are not checkable. As a result,
M-l B's growth rate has been inflated this year
because it contains a coml Xlnent which it did
not include in earlier years. Moreover,
although funds transferred from savings to
N OWs may be used to make payments, their
owners probably will continue to treat them
as savings rather than transaction accounts.
This poses a problem for the Fed because it
wishes to control the rate of growth of
transaction balances. Therefore, the Fed has
attempted to construct a statistical magnitude
comparable to the earl ier M- 1 B series by
adjusting the data to exclude balances shifted
to newly opened N O W accounts in 1981
from sources other than demand deposits.
However, it is difficult to obtain information
on the proportion of new N OW accounts
which are not truly transaction balances. The
Fed views its estimates of this prolXlrtion as
being subject to rather wide margins of error.

accounts into thrift-institution N OW
accounts-or movements of funds between
and within thrifts. The result is an
under-estimation of the share of new N OWs
. coming from savings accounts. Other data
sources, however, provide some indication
of shifts of funds between banks and thrifts.
The Fed finally obtains information
from a series of surveys of households
conducted by the Survey Research Center at
the University of Michigan. These surveys,
however, are designed to gain information
about a variety of household decisions and
attitudes, so that a random sample of
households at.large may not be
representative of N OW account-holders.


1B' ..

These various estimation procedures provide
similar results, despite all the statistical and
conceptual problems involved. They suggest
that time and savings accounts provided
between 20 and 25 percent of the N OWs
opened in January 1981, and 25 to 30
percent of those opened in later months.

Sources of N OW data
The Fed obtains its information, first, from
surveys of banks and thrift institutions
regarding sources of new N OW accounts.
However, an institution receiving a new
N OW account has no sure way of knowing
the source of the funds except for those
transferred from another account within the
same institution. For example, although a
customer opens a N OW account with a
,check drawn on a bank checking account,
this does not necessarily mean that that
account was the original source of the funds,
which may have been shifted from some
other type of account only to permit the
switch to the other institution.

Using the midpoints of these estimated
ranges, the Fed now publishes data on
"shift-adjusted M-1 B," which represents
M-1 B minus the portion of new N OW
accounts estimated to have come from
non-demand delXlsit sources. Each month,
the total increase in N OW accounts (apart
from a small "trend" increase) is split into
two parts, depending on the source of the
original funds. The portion estimated as
coming from non-transaction sources is
deducted from the total increase in M-l B for
that month to yield an estimate of the increase
in shift-adjusted M-1 B. The levelof adjusted
M-1 B then equals the cumulative sum of
these monthly increases.

The Fed also obtains information from a
statistical analysis of weekly changes in
demand deposits and N OW accounts at
about 9,000 commercial banks nationwide.
This analysis attempts to measure the extent
to which increases in N OW accounts are
associated with the loss of traditional
checking accounts. This approach fails to
capture shifts of funds from bank checking

This adjusted aggregate rose from $415.6
billion in December 1980to $423.9 billion in
April 1981, but then declined to $420.2
billion in July. For the entire December-July
period, this represented only a 1.9-percent
annual rate of growth, so that adjusted M-l B




. Growth

Money Supply (M-1


. Growth



__ M-1B Adjusted












Implications policy

tell below the lower bound of the Fed's 1981
target range. By contrast, M-1 B without a shift
adjustment increased at a 6.0-percent annual
rate between December and July.

These two alternative explanations may have
different implications for monetary policy in
1982. This reflects the fact that most of the .
shift of funds into N OW accounts will
probably be completed by the end of 1 981 ,
whereas high interest rates could continue to
induce financial innovations and reduce
mqney demand for some time into the future.

Many analysts attribute the recent rise
in interest rates, deceleration of inflation
and reduction of real growth to this
slowdown in M-1 B. Nonetheless, nominal
GN P has risen substantially faster in 1981
than might have been expected from past
relationships of money, income and interest
rates. As we argued in the last Weekly Letter,
statistical tests using shift-adjusted M-1 B data
suggestthat equations explaining this relation
were much less successful in 1981 than in
earl ier periods.

Once the shift into N OWs is complete, this
factor will no longer affect the observed
monetary growth rate. Even a too high estimate of the share of N OW accounts coming
from non-transaction balances would not
significantly affect the estimated growthrate
of M-1 B once the shift is complete, so that the
Fed would have no need to alter previously
announced targets for monetary growth in
1 982. On the·other hand, a downward shift in
money demand, if continued into 1982,
would imply not only less restrictiveness than
projected in past targets, but also a continuation of that situation in the future. This would
imply a need for downward adjustment of
future targets.

This phenomenon may perhaps be explained
in terms of a falling demand for money,
which has permitted the economy to finance
a substantial rise in the volume of
transactions with only a modest increase in
the stock of transaction balances. Last week,
we argued that recent financial innovations,
such as the growth of money-market mutual
funds, might be involved in such a reduction
of money demand.

At present, there appears to be no rei iable
way of judging which of these explanations is
the correct one. However, both imply thatthe
Fed should lower its targets for 1 981 . Federal
Reserve Chairman Volcker recently
announced that the Fed planned to aim for
the lower bound of its 1981 target during the
remai nder of th is year. Such a move wou Id be
dictated either by a downward shift in money
demand or by a finding of error in the
N OW-account adjustment. In the former
case, any adjusted M-1 B growth rate is less
restrictive than wou Id have been true in the
past. In the latter case, the appropriatelyadjusted supply of (M-1 B) money is growing
more rapidly than currently estimated.

Alternatively, this phenomenon may result
from a faulty N OW-shift adjustment-in
other words, less N OW-account money has
come from non-transaction sources than is
currently assumed. As we noted, the Fed's
estimate of this proportion is subject to error,
as shown by the fact that the Fed bases its
adjustment on the midpoint of an estimated
range. This suggeststhat the "true" stock of
transaction balances may be greater than
currently estimated-and that M-1 B may
have grown faster this year than the estimated
1.9-percent annual rate. That is, rather than a
falling demand money, we may be
experiencing a higher supply of money than
suggested by the official data. However, this
argument is weakened by the fact that the
error may go in either direction.

BrianMotley andJohnP.Judd